China added to bond investors’ jitters on Wednesday as traders braced for what they feared could be the end of a three-decade bull market.

Senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, according to people familiar with the matter. The news comes as global debt markets were already selling off amid signs that central banks are starting to step back after years of bond-buying stimulus. Yields on 10-year Treasuries rose for a fifth day, touching the highest since March.

China holds the world’s largest foreign-exchange reserves, at $3.1 trillion, and regularly assesses its strategy for investing them. It isn’t clear whether the officials’ recommendations have been adopted. The market for U.S. government bonds is becoming less attractive relative to other assets, and trade tensions with the U.S. may provide a reason to slow or stop buying American debt, the thinking of these officials goes, according to the people, who asked not to be named as they aren’t allowed to discuss the matter publicly. China’s State Administration of Foreign Exchange didn’t immediately reply to a fax seeking comment on the matter.

The Chinese officials didn’t specify why trade tensions would spur a cutback in Treasuries purchases, though foreign holdings of U.S. securities have sometimes been a geopolitical football in the past. The strategies discussed in the review don’t concern daily purchases and sales, said the people. The officials recommended that the nation closely watch factors such as the outlook for supply of U.S. government debt, along with political developments including trade disputes between the world’s two biggest economies when deciding whether to cut some Treasury holdings, the people said.

A top Treasury official signaled confidence in the U.S. government debt market, which at $14.5 trillion is the world’s largest.

“The U.S. Treasury market is a deep, robust market within the world and so we are confident that our economy, with the economy strengthening, that it will remain a deep, robust market,” Under Secretary for International Affairs David Malpass told a group of reporters in Brussels.

Read here about a 1990s episode regarding Treasuries, with Japan.

The 10-year Treasury yield was about four basis points higher at 2.59 percent as of 8:48 a.m. in New York.

Any reduction in Chinese purchases would come just as the U.S. prepares to boost its supply of debt. The Treasury Department said in its most recent quarterly refunding announcement in November that borrowing needs will increase as the Federal Reserve reduces its balance sheet and as fiscal deficits look set to widen.

“It’s a complicated chess game as with everything the Chinese do,” said Charles Wyplosz, a professor of international economics at the Graduate Institute of International and Development Studies in Geneva. “For years they have been bothered by the fact that they are so heavily invested in one particular class of U.S. bonds, so it’s just a question of time before they would try to diversify.”

Some investors said that the market could take the China news in stride, considering the nation’s net purchases of Treasuries have already slowed “significantly.”

“If China ceases to be a net purchaser of U.S. Treasuries, this is unlikely to have a significant impact on the overall yield curve unless China divests a large share of its total holdings in a short time period,” said Rajiv Biswas, Singapore-based chief Asia-Pacific economist at IHS Markit.

Yields were already climbing this week amid expectations the improving global economy will boost inflation pressures round the world, just as major central banks scale back their asset purchases.

Markets are also braced for a deluge of debt supply this week. The U.S. is scheduled to reopen $20 billion of 10-year debt Wednesday, followed by $12 billion of 30-year bonds Thursday. Germany sold 4.03 billion euros of 0.5 percent 10-year bonds Wednesday with syndications in Italy and Portugal to follow.

Bill Gross: Bear Market in Bonds Is Already Here
Gross says the bear market started in July 2016 when the 10-year Treasury yield fell to 1.45%

U.S bonds are in a bear market that started in July 2016 when the 10-year Treasury note “double-bottomed at 1.45%,” says Bill Gross, the Pimco co-founder who’s now a portfolio manager for the Global Unconstrained Bond and Total Return strategies at Janus Henderson.

The July bottoms signified the end of a bull market that began 35 years earlier, but they weren't recognized as such at the time, notes Gross in his latest market outlook.

“Eighteen months ago, it was obvious to most observers that the economy, measured by nominal GDP, was not going to go much lower than 3% and that the Fed was having second thoughts about quantitative easing,” but the bond market wasn’t priced for that, writes Gross. It was priced instead for “perpetual QE and the possibility of a deflationary collapse in the economy” — neither of which happened.

The U.S. government is set to borrow nearly $1 trillion this year, an 84 percent jump from last year

Spoiler:

t was another crazy news week, so it's understandable if you missed a small but important announcement from the Treasury Department: The federal government is on track to borrow nearly $1 trillion this fiscal year — Trump's first full year in charge of the budget.

That's almost double what the government borrowed in fiscal year 2017.

Here are the exact figures: The U.S. Treasury expects to borrow $955 billion this fiscal year, according to a documents released Wednesday. It's the highest amount of borrowing in six years, and a big jump from the $519 billion the federal government borrowed last year.

Economy & Business Email Alerts

Breaking news about economic and business issues.

Sign up
Treasury mainly attributed the increase to the “fiscal outlook.” The Congressional Budget Office was more blunt. In a report this week, the CBO said tax receipts are going to be lower because of the new tax law.

24:43
Watch Trump’s full speech on the economy

0:00

President Trump said during a Jan. 18 speech in Coraopolis, Pa., that Republicans’ tax overhaul is already benefiting the U.S. economy. (The Washington Post)

The uptick in borrowing is yet another complication in the heated debates in Congress over whether to spend more money on infrastructure, the military, disaster relief and other domestic programs. The deficit is already up significantly, even before Congress allots more money to any of these areas.

“We're addicted to debt,” says Marc Goldwein, senior policy director at Committee for a Responsible Federal Budget. He blames both parties for the situation.

What's particularly jarring is this is the first time borrowing has jumped this much (as a share of GDP) in a non-recession time since Ronald Reagan was president, says Ernie Tedeschi, a former senior adviser to the U.S. Treasury who is now head of fiscal analysis at Evercore ISI. Under Reagan, borrowing spiked because of a buildup in the military, something Trump is advocating again.

Trump didn't mention the debt — or the ongoing budget deficits — in his State of the Union address. The absence of any mention of the national debt was frustrating for Goldwein and others who warn that America has a major economic problem looming.

“It is terrible. Those deficits and the debt that keeps rising is a serious problem, not only in the long run, but right now,” Harvard economist Martin Feldstein, a former Reagan adviser, told Bloomberg.

The White House got a taste of just how problematic this debt situation could get this week. Investors are concerned about all the additional borrowing and the likelihood of higher inflation, which is why the interest rates on U.S. government bonds hit the highest level since 2014. That, in turn, partly drove the worst weekly sell-off in the stock market in two years.

The belief in Washington and on Wall Street has long been that the U.S. government could just keep issuing debt because people around the world are eager to buy up this safe-haven asset. But there may be a limit to how much the market wants, especially if inflation starts rising and investors prefer to ditch bonds for higher-returning stocks.

“Some of my Wall Street clients are starting to talk recession in 2019 because of these issues. Fiscal policy is just out of control,” says Peter Davis, a former tax economist in Congress who now runs Davis Capital Investment Ideas.

The Federal Reserve was also buying a lot of U.S. Treasury debt since the crisis, helping to beef up demand. But the Fed recently decided to stop doing that now that the economy has improved. It's another wrinkle as Treasury has to look for new buyers.

Tedeschi, the former Treasury adviser to the Obama administration, calls it “concerning, but not a crisis.” Still, he says it's a “big risk” to plan on borrowing so much in the coming years.

Trump's Treasury forecasts borrowing over $1 trillion in 2019 and over $1.1 trillion in 2020. Before taking office, Trump described himself as the “king of debt,” although he campaigned on reducing the national debt.

The Committee for a Responsible Federal Budget predicts the U.S. deficit will hit $1 trillion by 2019 and stay there for a while. The latest borrowing figure — $955 billion — released this week was determined from a survey of bond market participants, who tend to be even faster to react to the changing policy landscape and change their forecasts.

Both parties claim they want to be “fiscally responsible,” but Goldwein says they both pass legislation that adds to the debt. Politicians argue this is the last time they'll pass a bill that makes the deficit worse, but so far, they just keep going.

The latest example of largesse is the GOP tax bill. It's expected to add $1 trillion or more to the debt, according to nonpartisan analysis from the Joint Committee on Taxation (and yes, that's after accounting for some increased economic growth).

But even before that, Goldwein points to the 2015 extension of many tax cuts and the 2014 delays in Medicare reimbursement cuts.

Bond Market’s Most Feared Traders Threaten Treasuries Once Again
By
March 12, 2018, 12:04 PM EDT Updated on March 13, 2018, 7:16 AM EDT
The vigilantes are poised to return after years in abeyance
Expansionary fiscal policy, resurgent inflation spur revival

Spoiler:

E. Craig Coats Jr. never set out to be a bond vigilante.

As the former head of Salomon Brothers’ Treasuries desk, the last thing on his mind running the world’s biggest debt trader in the 1970s and 80s was fighting Washington’s fiscal largesse. He had a much simpler agenda: survive.

In an era when inflation outbreaks could send yields surging hundreds of basis points in a matter of days, getting stuck on the wrong side of the bond market could end your career. That’s why for Coats, any hint consumer prices were poised to spike was a sign to sell with both hands. The knock-on effect, of course, was that he inadvertently became a disciplinarian of American budgetary freewheeling, forcing officials to curb inflationary policies or risk an upward spiral in funding costs.

It’s been a generation since traders like Coats last imposed their will on Washington and Wall Street alike. Yet the original vigilante says he’s seeing signs that the once feared punishers of profligate spending are lurking again, lured back by an expansionary fiscal policy and signs of resurgent inflation -- just as the world’s central banks dial back years of unprecedented bond buying that’s largely shielded politicians from market pressures.

“Some of the stirrings from what we used to know about the old days of inflation are really starting to rear their head,” Coats, now retired, said from Florida. Back then “people paid a lot more attention to the deficits and the cost from the standpoint of what it was to the Treasury. Not so much now, but I think those days are going to be coming back.”

No one is predicting a return to the bond markets of yesteryear, in which the guardians against government excess could stymie political agendas and dictate the course of policy. Central banks remain a domineering force, even if their sway is set to erode. Foreign demand for U.S. debt remains robust. And a brewing trade war between America and its allies is stoking demand for haven assets once again. Yet signs the vigilantes are reemerging can be seen across the $14.7 trillion Treasuries market.

Spending Surge
Congress’s bipartisan vote last month to increase spending by nearly $300 billion over the next two years comes on the heels of the $1.5 trillion, 10-year tax cut President Donald Trump signed into law in December. Wall Street strategists have slated over $1 trillion in new debt issuance this year alone to fund them.

That’s only expected to grow as an aging population further fuels entitlement outlays while rising interest rates buoy Washington’s debt-servicing costs. The White House’s 2019 budget proposal released last month would raise the deficit to $984 billion, nearly double projections from last year. The red ink would total $7.1 trillion over the next decade, pushing the national debt to nearly $30 trillion.

“This is a big problem, not just short term deficits but the debt,” said Liz Ann Sonders, chief investment strategist for Charles Schwab & Co. “We are playing with a lot of large numbers now. It changes the supply-demand dynamic in the Treasury market.”

To keep pace with this rising shortfall, net Treasury issuance to the public will average $1.27 trillion per year over the next five years, according to strategists at BMO Capital Markets. That compares to an average of $658 billion over the past five years. Monday, investors digested a whopping $145 billion of fresh supply, including an unusual double sale of 3- and 10-year maturities, demanding the highest yields in years on the notes to absorb the larger auction sizes.

Ballooning Burden
U.S. borrowing is forecast to keep on rising

Source: Congressional Budget Office

The fiscal stimulus comes as data on employment, wages and consumer prices have all exceeded analyst estimates in recent months, only further stoking inflation concerns.

“We’ve had the tax cuts, fiscal stimulus and strong growth combined with all-time highs levels of optimism in surveys -- and people are putting it all in their Phillips curve models and saying ‘Oh God, we are going to have inflation,” said Jim Bianco, president of Chicago-based Bianco Research, referring to theory that falling unemployment is met with faster inflation.

Read more: Dollar under siege as deficits back on Wall Street’s radar

Investors and strategists have taken heed.

The 10-year break-even rate, calculated from the difference between yields for nominal and inflation-linked bonds, reached 2.15 percent last month, the highest since 2014. Traders already wagering the Federal Reserve will increase rates three times this year are beginning to position for the possibility of a fourth. And of course, two-year yields have breached 2% for the first time since 2008, while 10-year yields are on the cusp of 3% for the first time in four years.

Analysts, in turn, are reexamining their 2018 yield forecasts. JPMorgan Chase & Co. last month lifted its year-end calls for the 2- and 10-year notes to 2.95 percent and 3.15 percent, respectively, from 2.7 percent and 2.85 percent. Strategists from Goldman Sachs Group Inc., Bank of America Corp., Deutsche Bank AG, Toronto Dominion Bank and BNP Paribas SA have also made upward revisions this year.

The benchmark 10-year yield was at 2.87 percent as of 7:15 a.m. in New York, little changed from its Monday closing level and up from 2.41 percent at the end of last year.

“Stimulative but unpaid for tax cuts in the late stages of the business cycle have pushed up bond yields to the point where it has already started to cause stress,” said Jeff Caughron, chief operating officer at Oklahoma City-based Baker Group, which advises community banks with over $45 billion in investments. “The Treasury is faced with the prospect of having to flood the market with all this supply to fund these deficits.”

Reagan, Clinton
For Ed Yardeni, who coined the term ‘bond vigilantes’ to describe investors who dump government debt in the face of policies they consider inflationary, it harks back three and a half decades ago. Surging expenditures under President Ronald Reagan sent the budget deficit to a post-World War II record 6 percent of gross domestic product in 1983, up from 1.6 percent in 1979, prompting money managers to shun Treasuries.

Ten years later, it was those same investors who famously torpedoed President Bill Clinton’s ambitious domestic agenda -- forcing him to scale back spending initiatives as long-end rates surged.

“They didn’t stop and frisk, they just started shooting,” said Yardeni, who heads a research firm that bears his name. “Inflation is key and the market has shown it won’t take much for them to push yields higher.”

As central banks around the world begin to dial back a decade of crisis-era bond buying that’s suppressed yields, bond vigilantes will increasingly make their presence felt, he added.

Price to Pay
The hit to debt-servicing costs from rising yields will be more powerful than ever. Outstanding marketable securities now total $14.7 trillion, more than four times what it was 20 years ago.

In fact, the tab to finance America’s debt burden has already begun to worsen. For the fiscal year that ended in September, interest expenditures rose to $459 billion, or 2.4 percent of GDP. That’s up from $433 billion for fiscal 2016.

Bank of America forecasts the federal deficit is on track to exceed 5 percent of GDP by 2019, the largest for a U.S. economy at full employment since the 1940s. The Congressional Budget Office last year predicted that public debt will increase by more than $10 trillion by 2027.

“Part of the reason we got here is that interest rates have been so forgiving,” said Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget. “But we are about to be reminded that the bond market is not sympathetic to inordinate amounts of government borrowing. The price we will have to pay when rates go up will be quite significant.”

To be sure, central banks will continue to limit the extent to which vigilantes can prod officials to curb inflationary policies. The Fed has already signaled its balance-sheet unwind will be slow and that it will continue to hold trillions of dollars in debt securities amassed during quantitative easing. At the same time, easy-money policies in Europe and Japan will continue to support foreign demand for Treasuries, particularly as the the U.S. raises interest rates.

Moreover, President Trump’s recent plan to impose levies on foreign steel and aluminum has fueled concern trade wars may be on the horizon, helping stall the 10-year Treasury yield’s ascent to 3 percent amid a flight to haven assets.

And above all, with long-term government debt yielding a mere fraction of the double-digit levels seen in the early 1980s, there remains significant headroom before debt-servicing costs begin to approach unsustainable levels, according to Coats.

Still, the 40-year bond-market veteran says traders should brace for more violent price swings than they’ve gotten accustomed to in recent years.

“This is clearly a worry that should be on people’s minds,” said Coats. “The vast majority of people on trading desks and running these portfolios have been on the desk for 15 or 20 years. If you are not used to what the volatility can be, there is risk.”

TREASURIES-U.S. 10-year yield at highest in four years on supply, inflation worry
* U.S. 10-year yield hits highest level since Jan. 2014
* U.S. yield curve steepens further from decade flat
* U.S. to sell $96 billion in coupon-bearing debt
* Long-term inflation gauges rise to highest since 2014

Spoiler:

NEW YORK, April 23 (Reuters) - U.S. bond prices fell on
Monday, with the 10-year yield hitting its highest in over four
years amid worries about the growing supply of government debt
and accelerating inflation as oil and commodity prices climb.
The U.S. Treasury Department will sell a combined $96
billion in coupon-bearing securities this week, starting with
$32 billion in two-year notes on Tuesday.
At 9:12 a.m. (1312 GMT), the yield on 10-year Treasury notes
was 2.975 percent, up 2 basis points from late on
Friday. It touched 2.998 percent earlier Monday, which was the
highest since January 2014, Reuters data showed.
"There are supply concerns. The auction sizes are getting
bigger," said Larry Milstein, head of agency and government
trading at R.W. Pressprich & Co. in New York.
The Treasury has ramped up its borrowing to fund its
operation following last year's massive tax overhaul and a
two-year budget agreement reached in February.
An expected jump in Treasuries supply is expected to lift
long-term borrowing costs, not only for the government but also
for consumers.
The two-year yield was 2.466 percent, nearly 1
basis point higher on the day after hitting 2.478 percent
earlier Monday, which was last seen in September 2008.
A further selloff in Treasuries steepened the yield curve
from its flattest levels in over a decade set last week.
The flattening move partly reflected some anxiety among
traders on whether the U.S. economic expansion is running out of
steam as expectations of more increases in short-term rates by
the Federal Reserve might slow business and consumer spending
and investment.
Meanwhile, some market gauges of U.S. long-term inflation
expectations hit their highest level in at least 3-1/2 years on
Monday, Reuters data showed.
The U.S. five-year, five-year inflation swap touched 2.5385
percent in early European trade for the first time since
November 2014.
The 10-year inflation breakeven rate, or the yield gap
between 10-year Treasury Inflation Protected Securities and
regular 10-year Treasuries, was 2.19 percent, touching its
highest level since August 2014, Tradeweb and Reuters data
showed.
Last week, global oil prices climbed to their
highest levels since November 2014 on supply and geopolitical
worries, boosting inflation expectations around the world,
analysts said. On Monday, U.S. crude futures fell more
than 1 percent to $67.39 a barrel.
The Federal Reserve's Beige Book of regional economic
conditions, released last Wednesday, showed domestic prices grew
across the United States in March through early April.